an economics scrapbook

The face of the river, in time, became a wonderful book . . . which told its mind to me without reserve, delivering its most cherished secrets as clearly as if it had uttered them with a voice.
-- Mark Twain

I ran across a great chart this morning that clearly illustrates how the best time to buy a home is when mortgage interest rates are high. This is important to understand in today’s market, when the contrary notion that low interest rates offer some sort of rare savings opportunity is used so heavily in marketing homes and home-buying financial products. This is a great time to refinance, but it is not a great time to buy a home.

This chart offers a nice visual depiction of how interest rates relate to home prices over time. (Click on image to enlarge.) When interest rates move lower, prices move higher and counteract any savings you might think you’re getting with the low rates. Notice the dotted line across the lower third of the chart indicating the long term median home price. Look at how much higher today’s median is, as indicated by the blue line. Home prices are still quite high historically. Remember, this chart represents the US national market, not hyper-inflated urban areas like Los Angeles and Manhattan, which remain well above the national average with the lingering effects of bubble euphoria still at work. Secondly, notice the pattern the red and blue lines make – how the blue price line travels in the opposite direction of the red interest rate line. You can clearly see how prices move up as rates move down, and visa versa.

If you’d have bought a house in 1981 when rates were around 18%, you’d also have been buying when prices were far below the historical norm. You’d then have had the chance to follow the interest rates down over time by refinancing at a much lower rate shortly thereafter (and again later, etc.), while maintaining the benefits of having purchased at a great price. If on the other extreme you’d bought a house in 2006 when prices were at their peak, you’d have paid a much lower rate of interest but you’d never have the opportunity to renegotiate that price (and, normally, the tax amount you’d have signed up to pay on that purchase). Refinancing as rates fell further would only have been possible if you were not “upside down” on your mortgage, owing more money on the house than the price it would sell for in the falling market. So, you can see clearly here it is much better to buy when prices are low than when interest rates are low. With today’s interest rates at historic lows and with bubble distortion still priced into the market in many areas, home prices have plenty of room to fall.